When looking for a stock that provides dividend income, be sure to check a company’s free cash flow to gauge whether it can continue to fund its dividend payment. When looking for “dividend stocks,” we look for high-dividend growth and talk about things like cash flow and payout ratios. Don’t fully understand these terms? Have no fear! Let’s take a look at what each of these metrics mean and why they are important:
Payout Ratio: It is the amount of earnings paid out to shareholders represented as a percentage. It is calculated as the dividends per share/earnings per share. A low payout indicates a company is keeping its earnings while a high payout ratio indicated the company uses its earnings for dividend purposes. This ratio also gives an investor an idea of how well the company’s earnings can support its dividend payments (generally, the higher, the better).